Deficit Financing, the Debt, and “Modern Monetary Theory” October 21, 2019 Congressional Research Service https://crsreports.congress.gov R45976
Deficit Financing, the Debt,
and “Modern Monetary Theory”
October 21, 2019
Congressional Research Service
https://crsreports.congress.gov
R45976
Congressional Research Service
SUMMARY
Deficit Financing, the Debt, and “Modern Monetary Theory” Explaining persistently low interest rates despite large deficits and rising debt has been one of the
central challenges of macroeconomists since the end of the Great Recession. This dynamic has
led to increasing attention to Modern Monetary Theory (MMT), presented as an alternative to the
mainstream macroeconomic way of thinking, in some fiscal policy discussions. Such discussions
are at times restricted by a difficulty, expressed by policymakers and economists alike, in
understanding MMT’s core principles and how they inform MMT’s views on fiscal policy. MMT
suggests that deficit financing can be used without harmful economic effects in circumstances of
low inflation rates and low interest rates, conditions that currently exist despite indications that
the country is at full employment.
This report surveys the available MMT literature in order to provide a basic understanding of the differences (or lack thereof)
between the defining relationships established in MMT and mainstream economics. It then explores how such distinctions
may inform policy prescriptions for addressing short- and long-run economic issues, including approaches to federal deficit
outcomes and debt management. Included in this analysis are observations of how policy recommendations from MMT and
mainstream economics align with current U.S. economic and governance systems.
In mainstream macroeconomic models, the asset market is characterized by the sensitivity of investment to interest rates, a
determinant of investment returns. Money is typically defined as cash and close substitutes, and used for transactions and
held as an asset. In the short run, the capital stock (equipment and other factors of production outside of labor) is assumed to
be fixed, and output is dictated by the employment level. Fiscal and monetary policy decisions can be used to expand or
contract the short-run economy (with distinct effects for each), and those decisions help to inform growth, the stock of capital
and labor, and other decisions in the long run. In general, expansionary fiscal policies, including stimulus policies and other
programs that increase net deficits and debt, are thought to be helpful when addressing negative shocks in demand, but they
may crowd out private investment and reduce long-term growth if used when the economy is otherwise in balance. Persistent
increases in real debt (which occurs when the stock of debt grows more quickly than the economy) are viewed as
unsustainable, as they would eventually lead to a lack of real resources to borrow against.
Though some MMT adherents have disputed the notion that the model can be viewed through the basic macroeconomic
framework, efforts to do so reveal a few key distinctions. In the MMT model of short-run behavior, investment decisions are
insensitive to interest rates, and are instead a function of current consumption levels. MMT holds a much broader view of
money, asserting that monetary value can be created by financial institutions in a way that renders monetary policy
ineffective in dealing with short-run economic fluctuations. MMT supporters therefore prefer a larger fiscal policy role in
managing business cycles than mainstream economists, generally claiming that fiscal borrowing constraints are less imposing
than mainstream economists believe in countries with a sovereign currency, and call for direct money financing of fiscal
policy actions by the central bank. The translation of the MMT approach to long-run output is unclear, though a jobs
guarantee supported by MMT adherents would likely change the nature of the relationship between employment and output
levels.
Full alignment with the economic and political system supported by MMT would likely involve a dramatic shift in the roles
and powers of U.S. fiscal institutions. Adopting an MMT framework would involve much more fiscal policy to account for a
reduced monetary policy role. Policymakers would also likely need to execute fiscal policy decisions more quickly than has
been done in the past in assuming an increased role in economic management.
Projections of future debt growth due to spending pressures from social programs have led to a current concern about deficit
financing, recognizing the institutional challenges in conducting tax and spending fiscal policy. MMT is largely focused on
short-run management of the economy, with tax and spending policies aimed at maintaining a fully employed economy
without inflation. The MMT approach appears to implicitly assume that a high level of debt will not be problematic because
it can be financed cheaply by maintaining low interest rates. Underlying this policy is the assumption that Congress can act
quickly to counteract deficit-driven inflation with tax increases or spending cuts that would allow the economy to maintain
low interest rates on public debt.
R45976
October 21, 2019
Grant A. Driessen Analyst in Public Finance
Jane G. Gravelle Senior Specialist in Economic Policy
Deficit Financing, the Debt, and “Modern Monetary Theory”
Congressional Research Service
Contents
Introduction ..................................................................................................................................... 1
Explaining Mainstream Economic Views ....................................................................................... 2
Short Run: The Business Cycle ................................................................................................. 2 Extensions of the Basic Model: Open Economy .............................................................. 12 Extensions of the Basic Model: Investment and the Accelerator ...................................... 12 Extension of the Model: Consumption and Labor a Function of the Interest Rate,
and Rational Expectations ............................................................................................. 12 The Long Run: Economic Growth .......................................................................................... 13
Modern Monetary Theory ............................................................................................................. 13
Money Supply and Demand (LM) .......................................................................................... 15 Determination of Output and Interest Rates ............................................................................ 16 Demand and Supply (AD-AS) ................................................................................................ 17 The Open Economy ................................................................................................................. 18
Does MMT Justify Deficit Financing? .......................................................................................... 19
Applying MMT to Federal Institutions ................................................................................... 21
References ..................................................................................................................................... 22
Figures
Figure 1. Expansionary Fiscal Policy in IS-LM .............................................................................. 4
Figure 2. Expansionary Monetary Policy in IS-LM ........................................................................ 5
Figure 3. Monetary Policy Options in IS-LM ................................................................................. 6
Figure 4. Monetary Policy Options in IS-LM ................................................................................. 7
Figure 5. Monetary Policy Options in IS-LM ................................................................................. 8
Figure 6. Aggregate Demand, Aggregate Supply, and Output ...................................................... 10
Figure 7. Aggregate Demand, Aggregate Supply, and Output ....................................................... 11
Figure 8. IS-LM Curves in an MMT Model .................................................................................. 17
Contacts
Author Information ........................................................................................................................ 23
Deficit Financing, the Debt, and “Modern Monetary Theory”
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Introduction Traditional macroeconomic theory addresses two main questions. First, macroeconomic theory
and policy seek to mitigate short-term economic fluctuations (or stabilize the economy) that leave
productive resources idle for a time. Second, macroeconomists seek to recommend public policies
that maximize living standards (economic growth) over the long term, while keeping debt at
sustainable levels. The role of monetary policy and the maintenance of a stable price level are
embedded in both issues.
In the past few years, the U.S. economy has experienced persistently low interest rates despite
near-full employment and federal deficits and debt significantly above their historical averages.
These characteristics have led to debate over the optimal trajectory of long-term federal debt in an
economic environment with relatively low borrowing costs. Recently, an economic theory outside
of mainstream economic views, called Modern Monetary Theory (MMT) by its proponents, has
been receiving attention in the public debate.1 Interest in this theory may in part reflect concerns
about the deficit financing needed for new spending programs in health, education, infrastructure,
and other areas. MMT suggests that deficit financing can be used without harmful economic
effects in circumstances of low inflation rates and low interest rates, conditions that currently
exist despite indications that the country is at full employment.2
This report first explains mainstream macroeconomic theory. It then surveys the available MMT
literature to provide a basic understanding of the differences (or lack thereof) between the
defining relationships established in MMT and mainstream economics. It next discusses whether
MMT can be used to justify deficit financing. Finally, it discusses how existing government
institutions may present barriers in adopting the prescriptions of MMT for managing the
economy.
Unlike mainstream macroeconomic theory, where consensus has been reached on how core
relationships translate into mathematical equations, there is no comparative mathematical
statement of MMT. Some academic economists have translated MMT into a mathematical
framework, and the explanation of the differences between mainstream and MMT theory are
based on those discussions.3 Proponents of MMT do not necessarily accept that framework,
however.
1 The editors of a recent journal issue devoted to MMT identify the following individuals as major proponents of
MMT: Stephanie Kelton, L. Randall Wray, William F. Mitchell, Eric Tymoigne, Dirk Ehnts, Scott T. Fullwiler, Fadel
Kaboub, Pavlina R. Tcherneva, and Warren Mosler. See “Introduction: Whither MMT?” Real-World Economics
Review, Issue No. 89, 2019, at http://www.paecon.net/PAEReview/issue89/FullbrookMorgan89.pdf. Stephanie
Kelton’s earlier papers were published under her former name, Stephanie Bell.
2 For a discussion of reasons for low interest rates, see CRS Insight IN11074, Low Interest Rates, Part 3: Potential
Causes, by Marc Labonte. For a discussion of reasons for low inflation rates, see Juan M. Sanchez and Hee Sung Kim,
“Why is Inflation So Low?” Regional Economist, First Quarter 2018, Federal Reserve Bank of St. Louis, at
https://www.stlouisfed.org/publications/regional-economist/first-quarter-2018/why-inflation-so-low; and Tyler Durden,
“Why Does Inflation Remain So Low: Goldman Answers,” Zero Hedge (blog), February 10, 2019, at
https://www.zerohedge.com/news/2019-02-10/why-does-inflation-remain-so-low-goldman-asnwers. The Goldman
analysis suggests one reason may be lower price increases for health care. CRS Insight IN11074, Low Interest Rates,
Part 3: Potential Causes, by Marc Labonte.
3 See Menzie D. Chinn, Notes on Modern Monetary Theory for Paleo-Keynesians, Spring 2019, at
https://www.ssc.wisc.edu/~mchinn/mmt_add2.pdf; and Nick Rowe, “Reverse-Engineering the MMT Model,” A
Worthwhile Canadian Initiative (blog), 2011, at https://worthwhile.typepad.com/worthwhile_canadian_initi/2011/04/
reverse-engineering-the-mmt-model.html.
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Explaining Mainstream Economic Views Although basic macroeconomic models vary in many ways, any macroeconomic model that
allows for fiscal and monetary policy to influence the economy has three relationships in the
economy that must be in balance: (1) the asset market where investment equals saving (called the
IS curve), (2) the money relationship where the supply and demand for money must equate
(commonly called the LM curve), and (3) the economy-wide relationship where aggregate
demand equals aggregate supply. The first two of these equations compose what is referred to as
the IS-LM model. These three relationships, in turn, determine output, prices, and the interest rate
in the economy.4 Macroeconomic models formalize the relationship between economic variables,
allowing researchers to quantify the effect of a change in one variable on the rest of the system
(also called comparative statics) and to observe how economic patterns align with model
predictions.
The IS-LM model is characterized by a limited role of expectations of future economic conditions
and sticky prices.5 While there are a number of different macroeconomic models, especially those
that add expectations, this section uses the simplified model, which forms the core of forecasting
models as well as models used by government agencies in projecting the economy. More
sophisticated forecasting models of the economy have many equations that capture variation in
types of goods, investments, and assets, but this simplified model can be used to explain the
standard model and provide a foundation for interpreting MMT.
Most academic research is directed toward more complex models (sometimes referred to as
modern macroeconomics), which are discussed briefly below. The basic IS-LM model is useful
for illustrating the differences in MMT and mainstream models.
Short Run: The Business Cycle
In mainstream macroeconomic models, the short run is characterized by fixed capital investment,
or that the equipment and nonlabor resources available to firms are fixed. Output decisions are
therefore a function of productivity, employment, and IS-LM outcomes.
The Investment-Savings Balance (IS)
The IS curve begins with the recognition that output (or income) is the sum of its components:
private consumption, investment, and government spending. For simplicity, this models a closed
economy; in an open economy there would be a fourth component, net exports. If consumption
and government spending are subtracted from output, the result is saving; thus, this relationship
could be restated as savings equals investment.
Consumption is a fraction of disposable income, which is income minus taxes. Therefore,
consumption rises when disposable income rises (which occurs when income rises and/or taxes
fall). While consumption depends on income and taxes, investment depends on the interest rate,
rising when interest rates fall and declining when they rise. As a result, there are a series of pairs
4 There are numerous presentations of IS-LM and aggregate demand and supply graphs available on the internet. See,
for example, Diptimai Kari, “Derivation of Aggregate Demand Curve (With Diagram), IS-LM Model,” at
http://www.economicsdiscussion.net/demand/aggregate-demand-curve/derivation-of-aggregate-demand-curve-with-
diagram-is-lm-model/15826.
5 Sticky prices refer to prices charged for certain goods and services that are relatively resistant to change in response to
changes in input costs or demand patterns.
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of income levels and interest rates where this relationship is in balance, and income is higher
when interest rates are lower.6
It is through this relationship that fiscal policy can be used to expand or contract the economy. If
government spending is increased, or if taxes are decreased (which increases disposable income
and therefore increases consumption), demand increases. The recipients of these increased
amounts of income then spend a portion of that income, which leads to successive rounds of
spending that are called multipliers.
Money Supply and Demand (LM)
Another critical relationship is that between money supply and money demand, which must be
equal for markets to clear. Money is composed of cash, including checking accounts, and its close
substitutes. Holding prices constant for the moment, and with a fixed money supply, there are two
uses of money. First, some money is needed to carry out transactions in the economy, and thus
more money is demanded as income (output) increases. Second, money is needed as a liquid form
of asset holdings, and the higher the interest rate, the less money is held because it earns no
interest and is exchanged for other forms of assets that earn interest. Similar to the IS curve, this
relationship also creates pairs of interest rates and output levels where money supply and demand
balance traces out a curve (the LM curve), this time with income higher as interest rates increase.
In this case, however, a fixed amount of money demand occurs when both output and interest
rates are high or when both are low. When interest rates are high, less money is desired as an asset
and more is freed up to support a higher level of transactions (and therefore income).
Determination of Output and Interest Rates
Where the IS and LM relationships intersect is where income and interest rates will be
determined in the economy, holding prices constant. With significant unemployment, any fiscal or
monetary stimulus would be transmitted into output effects, moving the economy closer to the
output achieved under full employment.
The effects of expansionary fiscal policy in the IS-LM model are shown in Figure 1. When
expansionary fiscal policy—through increased spending, decreased taxes, or some combination of
the two—occurs (IS1 to IS2) and the money supply remains fixed (LM), interest rates (r) will rise
(point A to point B). This rise occurs because when more money is needed for transactions,
money held as an asset must be reduced and interest rates must be higher. This rise in interest
rates offsets some of the effects of increased income by reducing investment. Thus, holding
money supply fixed, increases in income (Y) that would have occurred if interest rates were fixed
is now reduced as investment decreases.
6 This pair of interest rate and output levels results, when graphed, is a downward sloping curve. This curve is normally
drawn with interest rates on the y (or vertical) axis and income or output on the x (or horizontal) axis.
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Figure 1. Expansionary Fiscal Policy in IS-LM
Notes: Interest rates (r) are measured on the y-axis, and output (Y) is measured on the x-axis. The IS curve
depicts the combination of interest rates and output levels consistent with the investment-savings relationship,
while the LM curve shows the combination of interest rates and output levels consistent with the money supply
and money demand relationship.
The monetary policy implications in an IS-LM model are illustrated in Figure 2. With
expansionary monetary policy (LM1 to LM2), more money is available to support income and
transactions at every interest rate (point A to point B). However, that level of income is
inconsistent with the level of income that balances the investment–savings (IS) relationship, and
interest rates fall, leading to more investment, with some of the increased money supply used to
hold more money as a liquid asset. That is, by interacting with the investment–savings (IS)
relationship, output and interest rates fall below the amount implied by the money expansion
alone. Output (Y) is higher than it was previously, and interest rates are lower. Thus, a monetary
expansion increases output and lowers interest rates.
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Figure 2. Expansionary Monetary Policy in IS-LM
Notes: Interest rates (r) are measured on the y-axis, and output (Y) is measured on the x-axis. The IS curve
depicts the combination of interest rates and output levels consistent with the investment-savings relationship,
while the LM curve shows the combination of interest rates and output levels consistent with the money supply
and money demand relationship.
Note that while the basic model uses monetary supply as the primary monetary policy tool, due to
difficulties in measuring the money supply, monetary authorities generally target interest rates
when making policy choices.
Figure 3, Figure 4, and Figure 5 show the basic ways monetary policy can respond to a fiscal
policy shift (in these examples through a contractionary fiscal policy shift) in an IS-LM model.
Monetary policy may be neutral (Figure 3) with respect to a fiscal contraction
(IS1 to IS2) if there is no change in the money supply, so that some of the output
effect is mitigated (point A to point B) relative to an accommodating policy.
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Monetary policy may be accommodating (Figure 4) if the money supply also
contracts (LM1 to LM2) to keep the interest rate constant, allowing maximum
output effects (in this case, reducing output) to occur (point A to point B).
Monetary policy may be offsetting (Figure 5) if the money supply expands (LM1
to LM2) to return output to its original level (point A to point B).
Figure 3. Monetary Policy Options in IS-LM
(in response to a contractionary fiscal policy shift)
Notes: The contractionary fiscal policy (a tax increase, spending decrease, or some combination of the two) is
represented with the move from IS1 to IS2. Interest rates (r) are measured on the y-axis, and output (Y) is
measured on the x-axis. The IS curve depicts the combination of interest rates and output levels consistent with
the investment-savings relationship, while the LM curve shows the combination of interest rates and output
levels consistent with the money supply and money demand relationship.
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Figure 4. Monetary Policy Options in IS-LM
(in response to a contractionary fiscal policy shift)
Notes: The contractionary fiscal policy (a tax increase, spending decrease, or some combination of the two) is
represented with the move from IS1 to IS2, and the contractionary monetary policy is represented with a move
from LM1 to LM2. Interest rates (r) are measured on the y-axis, and output (Y) is measured on the x-axis. The IS
curve depicts the combination of interest rates and output levels consistent with the investment-savings
relationship, while the LM curve shows the combination of interest rates and output levels consistent with the
money supply and money demand relationship.
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Figure 5. Monetary Policy Options in IS-LM
(in response to a contractionary fiscal policy shift)
Notes: The contractionary fiscal policy (a tax increase, spending decrease, or some combination of the two) is
represented with the move from IS1 to IS2, and the expansionary monetary policy is represented with a move
from LM1 to LM2. Interest rates (r) are measured on the y-axis, and output (Y) is measured on the x-axis. The IS
curve depicts the combination of interest rates and output levels consistent with the investment-savings
relationship, while the LM curve shows the combination of interest rates and output levels consistent with the
money supply and money demand relationship.
Demand and Supply (AD-AS)
The LM curve actually has a third variable, the price level. The real money supply depends on the
price level; if prices rise and nominal money supply is fixed, the real money supply falls. Thus,
there is a third relationship in the system.
This relationship requires an equilibrium between aggregate demand and aggregate supply (AD-
AS). In the short run, the capital stock is fixed, and the output in the economy depends on hiring
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unemployed labor. (There is also an underlying labor supply and labor demand relationship.) The
effects are captured in the aggregate supply equation. As prices rise, the supply of output
increases and the demand decreases. Thus, this relationship shows an equilibrium aggregate price
level and output in the economy.7
As shown in Figure 6 and Figure 7, the effect of fiscal and monetary policies on output (Y) and
the price level (P) is a function of aggregate supply and demand. Either a fiscal or monetary
expansion will shift the aggregate demand curve toward more output at every price level. The
supply curve is relatively flat when there is significant underemployment in the economy,
meaning that output can increase without affecting prices. When the economy is at full
employment the supply curve is almost vertical, and a shift in the demand curve will increase
prices and not output.
7 Drawn on a graph, with price on the y (vertical axis) and output on the x (horizontal) axis, the aggregate demand
curve is downward sloping and the aggregate supply curve is upward sloping.
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Figure 6. Aggregate Demand, Aggregate Supply, and Output
Notes: The price level (P) is measured on the y-axis, and output (Y) is measured on the x-axis. The AD curve
represents the combinations of prices and output consistent with aggregate demand, while the AS curve
represents the combination of prices, and output consistent with aggregate supply.
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Figure 7. Aggregate Demand, Aggregate Supply, and Output
Notes: The price level (P) is measured on the y-axis, and output (Y) is measured on the x-axis. The AD curve
represents the combinations of prices and output consistent with aggregate demand, while the AS curve
represents the combination of prices and output consistent with aggregate supply.
An increase in the price level will decrease the real money supply. If the initial stimulus were a
fiscal stimulus, the real money supply would contract, at full employment, to restore the old
output level, but with higher interest rates. In effect, the fiscal stimulus would have substituted
consumption or government spending for investment (referred to as crowding out). If the stimulus
were originally a monetary stimulus, the real money supply would shift back to its old position
and neither the output nor its composition would change. Continual attempts to provide stimulus
at full employment would result in a continually increasing price level and, in the case of a fiscal
stimulus, continued crowding out of investment.
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Extensions of the Basic Model: Open Economy
This basic model can be expanded in many ways with increased complication and detail. As
suggested above, multiple sectors, multiple types of investments, and other details can be
introduced.
One important element is to allow for an open economy, with exports and imports, foreign
investment in the United States, and U.S. investment in foreign countries. Expanding the model in
this way, in its simplest form, requires a new relationship, the balance of payments, which
requires equal supply and demand for U.S. dollars. This additional relationship requires a new
variable, the exchange rate. It also requires net exports in addition to consumption, investment,
and government spending, to be added to the IS equation.
An open economy tends to diminish the effect of fiscal stimulus. As interest rates rise in the
United States, foreign capital is attracted into the United States. To make those investments,
foreigners demand dollars and supply foreign currency. The increased dollar demand increases
the price of the dollar in foreign currency, and this higher price makes exports more costly and
imports less costly. This results in a decrease in net exports, reducing the increase in output. In the
extreme, if international capital were perfectly mobile and the United States were a small country,
any effect of a fiscal stimulus would theoretically be completely offset, leading to a substitution
of consumption and government spending for net exports. Because capital is not perfectly mobile
and the United States is a large country, fiscal policy should still be effective in stimulating or
restraining the economy.
Monetary policy theoretically becomes more powerful in an open economy: as an increase in the
money supply causes the interest rate to fall, capital flows out of the country, causing net exports
to rise.
Extensions of the Basic Model: Investment and the Accelerator
Another modification to the model is to recognize that investment can respond to expected
demand. With this extension, as the economy expands and that expansion is expected to be
sustained, firms will increase investment in capital goods (known as the accelerator effect),
thereby increasing their capacity. The rate at which capital accumulates in an expanding economy
will therefore reflect the rate at which capital investment increases in response to output and the
rate of capital depreciation (or how much capital value is lost in any one period) over time.8
Extension of the Model: Consumption and Labor a Function of the Interest
Rate, and Rational Expectations
Economists had long been concerned that the IS-LM model does not fully account for
expectations of future behavior, and lacked the microeconomic foundations where individuals
allocate consumption and leisure over time. One way to incorporate such an idea is to make
consumption determined by the interest rate as well as disposable income, reflecting the idea that
as the interest rate rises individuals want to save more (and consume less). This effect has also
been extended to the allocation of leisure and labor, and is most formally contained in dynamic
stochastic general equilibrium (DSGE) models.9 DSGE models include a demand block, a supply
8 For more on this model extension, see Dale W. Jorgenson, “Capital Theory and Investment Behavior,” American
Economic Review, vol. 53, no. 2 (May 1963), p. 247.
9 The DSGE model is related to another class of models called real business cycle models (RBC). RBC models have
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block, and a monetary policy relationship. In general, while modifications could easily allow
consumption to depend on interest rates, use of a full-blown DSGE model is more common
among academics than among private forecasters or government forecasters.10 The model has
been criticized by a number of mainstream academics.11
The Long Run: Economic Growth
Over the long run, economic business cycle models converge into economic growth models.
Economic growth in the longer term is assumed to be at full employment, and the economy grows
with the labor force, capital accumulation, and technological advances. The long run, unlike the
short run (where the economy can gain from reducing unemployment), is characterized by fixed
resources and tradeoffs. What is most relevant to fiscal and monetary stimulus is that mainstream
economic theory suggests that using fiscal stimulus may be good for growth in the short run, but
can be harmful in the long run. If fiscal deficits allow consumption to increase at the expense of
investment, as would be the case with running the deficit that causes the debt to grow faster than
GDP, the economy will continually experience slower growth as the capital stock fails to grow at
a quick enough pace. Excessive monetary stimulus, meanwhile, would lead to price level
increases that, if followed persistently would lead to an inflationary spiral.
The most common growth model is one that reflects a more or less steady-state growth (although
that growth pattern may reflect growth in the labor supply).12
Modern Monetary Theory This section explores MMT’s basic macroeconomic principles and distinctive characteristics and
discusses how to interpret the model into the more conventional IS-LM framework. Because
MMT is an emerging ideology, definitively identifying the research that encapsulates it can be
difficult. Publications and other works from both proponents of MMT and mainstream
economists used in this report are listed in the references section. Though some MMT proponents
have expressed caution in viewing MMT through a traditional macroeconomic framework, this
approach is consistent with work found both elsewhere in the MMT literature and in mainstream
infinitely lived individuals, which limits the power of monetary and fiscal policy. For example, a cut in taxes will have
to be paid in higher taxes in the future, and infinitely lived individuals will therefore save those taxes. Money does not
exist in such a model, and business cycles are caused by individuals voluntarily shifting their labor supply over time.
The DSGE model is augmented to allow policy effects. See Jose-Victor Rios-Rull, “Life Cycle Economies and
Aggregate Fluctuations,” The Review of Economic Studies, vol. 63, no. 3 (July 1996), pp. 465-489.
10 For a discussion, see N. Gregory Mankiw, “The Macroeconomist as Scientist and Engineer,” Journal of Economic
Perspectives, vol. 20, no. 4 (Fall 2006), pp. 29-46. This paper also a history of the development of macroeconomic
modeling.
11 See Paul W. Romer, “The Trouble with Macroeconomics,” September 2016, at https://paulromer.net/the-trouble-
with-macro/WP-Trouble.pdf; and Joseph E. Stiglitz, “Where Modern Macroeconomic Went Wrong,” Oxford Review of
Economic Policy, vol. 34, iss.1-2 (Spring-Summer 2018), pp. 70-106, at https://academic.oup.com/oxrep/article/34/1-2/
70/4781816. These criticisms reflect, in part, concerns that the stringent assumptions of the model are not consistent
with observed behavior.
12 This model is commonly referred to as a Solow growth model, although it can be modified to allow supply side
responses such as labor supply that is responsive to the wage rate or consumption that is responsive to the interest rate.
The growth version of the model connected with a DSGE model is a Ramsey model, again where the economy is
composed of a single, infinitely lived, perfectly informed, and optimizing agent. Related to the Ramsey model is the
life cycle model, where individuals live finite lifetimes and generations die and are born, but are still agents
characterized by perfect foresight.
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economic analysis, including research with theoretical elements aligning with some of MMT’s
central assertions.13
MMT’s theory does not take into account self-imposed constraints (i.e., those other than resource
constraints), such as lack of a sovereign currency, or of other institutions, such as independence of
the monetary authority (the Federal Reserve in the United States) and the Treasury that allows the
creation of money to finance government spending. As will be discussed subsequently, U.S.
institutions may limit the application of MMT to the management of the economy.
As with all macroeconomics, some of the theory is about description and some about prescription,
but MMT varies by including prescriptive points that restrain monetary policy to keep a fixed
interest rate (this policy will leave fiscal policy as the only tool to address the business cycle).
According to the model, when fiscal stimulus produces no inflation, there are still unused
resources in the economy, and when fiscal stimulus leads to inflation, the stimulus will be
reduced or reversed, thereby reducing the deficit or converting it to a surplus.
The Investment-Savings Balance (IS)
Just as with the basic macroeconomic model, analysis of MMT’s macroeconomic principles may
begin by accounting for all the choices available with output in a closed economy, which are
private consumption, investment, and government spending.14 In equilibrium (when aggregate
expenditures are equal to output), this accounting identity can be reframed to show that the
difference between national saving and investment is equal to the difference between government
spending and government taxes (or the federal budget deficit), which can also be found in the
basic approach.
One notable distinction between MMT and the basic macroeconomic structure is that MMT
assumes private investment levels are insensitive to changes in the interest rate (or the rate of
return that investment would offer), at least when the economy is below capacity.15 The
insensitivity of investment to interest rates means that unlike the basic model, where there are a
series of output and interest rate combinations where the investment and savings levels are in
balance, with MMT desired investment and savings are equivalent at a single level of output,
regardless of the interest rate. This relationship alone (which may be described as having a
vertical IS curve) is possible in certain permutations of the basic macroeconomic model. As with
the basic approach, consumption may be a positive function of income with the MMT investment
and interest rate assumption.
13 See Menzie D. Chinn, “Notes on Modern Monetary Theory for Paleo-Keynesians,” Spring 2019, at
https://www.ssc.wisc.edu/~mchinn/mmt_add2.pdf; Nick Rowe, “Reverse-Engineering the MMT Model,” A
Worthwhile Canadian Initiative (blog), 2011, at https://worthwhile.typepad.com/worthwhile_canadian_initi/2011/04/
reverse-engineering-the-mmt-model.html; and Victoria Chick, The Theory of Monetary Policy, vol. 5 (London: Gray-
Mills Publishing Limited, 1973). The first two of these resources are available online and provide graphical
presentations.
14 MMT adherents have expressed caution in analyzing the theory through this macroeconomic framework, due to
concerns that it does not accurately capture economic activity with unique financial flows (present in markets like
housing). There are also concerns about the treatment of income that doesn’t fit cleanly into such a “stock and flow”
model, like unrealized capital gains—although that activity would be recorded as income when realized, it is possible
that it influences household behavior when held. Mainstream economists have made similar criticisms of the limitations
of this basic macroeconomic structure. It is unclear how accounting for that activity would affect the core findings of
the model presented here.
15 This view appears to be based on the idea that when the economy is below capacity, firms are unwilling to make
investments because of lower interest rates (although whether that argument should apply to investments in owner-
occupied housing is not clear). See Bill Mitchell, “Why Investment Expenditure is Insensitive to Monetary Policy,” at
http://bilbo.economicoutlook.net/blog/?p=31206.
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Fiscal policy may still be used to influence economic outcomes in the short run with an
investment–savings relationship consistent with MMT. In the basic model, the effect of
expansionary fiscal policy (or an increase in the deficit, or spending more than received in taxes)
would, all else equal, increase interest rates, which would thereby reduce private investment and
influence present and future saving and consumption patterns. Under the MMT condition,
investment levels would be unaffected by the change in interest rates caused by the shift in
government activity. Expansionary fiscal policy (as seen in Figure 1) would therefore still
increase income and output in a given period, with a decrease in government deficits having the
opposite effect.
Even if the IS curve is sensitive to interest rates, the same outcome could be achieved by an
accommodating money supply response that keeps the interest rate fixed (which is also a part of
the MMT approach, as discussed below), although this outcome would be the result of a policy
choice rather than of fundamental economic factors.
Money Supply and Demand (LM)
As with mainstream macroeconomic theory, equilibrium in MMT requires equivalence between
money supplied and money demanded. The concept of money, however, is applied differently in
MMT than in mainstream macroeconomics, which has ramifications for money’s relationship
with other economic variables and how it may be managed by monetary and fiscal policy.
Rather than taking money as the cash and close substitutes created by a central bank, MMT
proponents believe that money in a financial system is legitimized as the government accepts it as
payment for taxes. In this view, government spending may be thought of as “creating” the money
that circulates in an economy. At the simplest level, assuming the Federal Reserve and the
Treasury are the same entity (ignoring self-imposed constraints), the monetary authority provides
the money to finance government spending (i.e., by depositing money in the Treasury checking
account) which injects money into the economy which is, in turn, used to pay taxes. In a more
complex model where the Federal Reserve supports the aims of the Treasury, the money would be
lent to the Treasury, directly or indirectly, and thus some discussions also speak of the
government lending money into existence.
This distinction in the concept of money alone does not generate differences in the beliefs about
the viability of long-term deficit financing (which is discussed further below). MMT proponents
assert that the interaction of market operations undertaken by banking institutions and Federal
Reserve actions that are designed to meet interest rate targets effectively allow banking
institutions to make their own lending choices independent of reserve requirements and other
restrictions. In their view, this greatly restricts the ability of the Federal Reserve (or any central
bank) to control the supply of money, even if they can influence market interest rates. Assuming
the central bank affects interest rates without direct control over the money supply is not
necessarily inconsistent with the mainstream macroeconomic approach.
The LM curve is horizontal because the target is the interest rate, although even if the interest rate
changed, it would not affect output (Figure 8 may be used as a reference). The central bank can
set any rate, but could set a low rate, perhaps near or at zero, which would lower the cost of
government borrowing (in situations where the central bank cannot directly add funds to the
government’s checking account).16 Again, the LM curve is not necessarily horizontal because it is
16 See, for example, M. Forstater and W. Mosler, “The Natural Rate of Interest is Zero,” Journal of Economic Issues,
vol. 39, no. 535 (2005), at http://www.moslereconomics.com/wp-content/graphs/2009/07/natural-rate-is-zero.PDF; and
Bill Mitchell, “The Natural Rate of Interest is Zero,” August 29, 2009, at http://bilbo.economicoutlook.net/blog/?p=
4656.
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naturally that way (MMT discussions do not present a formalized LM curve), but it is horizontal
if a fixed interest rate is targeted. The level of that fixed interest could be chosen at any rate,
although many adherents support a zero nominal interest rate. Such an interest rate could be made
consistent with a low and stable rate of inflation by changing fiscal policy (e.g., if inflation is
increasing, taxes should be increased and spending cut). Setting a determinable price level
requires a contractionary fiscal policy when demand exceeds potential output to prevent
continuing inflation.
MMT’s notion that monetary policy can maintain any chosen interest rate over an extended time
period is a significant deviation from mainstream monetary theory. That assertion requires the
absence of any other significant economic force influencing interest rates, including the effects of
expected inflation. The existence and impact of inflation expectations is well documented and
supported in the economic literature.17 If there are such nonmoney influences, the adoption of a
chosen interest rate may only be maintained with constant injections of money that cause
consequent inflationary pressures. Contractionary fiscal policy may not by itself be able to
constrain these pressures. The notion that a sovereign government can generate as much money
as it chooses without inducing inflation is another notable deviation of MMT from conventional
economic analysis.
In examining writings by MMT proponents, it is not always clear whether the reliance on fiscal
policy (rather than monetary policy) to address an underemployed economy is descriptive (only
fiscal policy works) or prescriptive (only fiscal policy should be used because it is too difficult to
undertake monetary policy). Proponents appear to believe that the monetary authorities can
influence interest rates, including through the buying and selling of bonds as well as directly
setting certain interest rates. It is also not clear whether the vertical IS curve is relevant only in an
underemployed economy. If the rule for monetary policy is not prescriptive and investment is
always insensitive to interest rates, it is difficult to square the theory with the use of monetary
policy in the early 1980s to contract the economy and squeeze out inflation, an event widely
accepted by economists and consistent with mainstream theory.
Determination of Output and Interest Rates
The MMT assumption of investment being insensitive to interest rates means that only fiscal
policy can be used to shift an underperforming economy to full output in the short run. Under
those assumptions, deficit financing in a recession would be an effective way of closing the
corresponding gap in output and income, and the Federal Reserve would be tasked with
restraining any subsequent increase in interest rates. This combination has been described as an
“extreme Keynesian” approach in the mainstream literature.18 The IS-LM curves generated by
MMT assumptions are shown in Figure 8.
17 Examples of such literature include John Y. Campbell and Robert J. Shiller, “The Dividend-Price Ratio and
Expectations of Future Dividends and Discount Factors,” Review of Financial Studies, vol. 1 (1988), 195; and John
Faust et. al., “The High-Frequency Response of Exchange Rates and Interest Rates to Macroeconomic
Announcements,” Journal of Monetary Economics, vol. 54 (2006), 1051.
18 Victoria Chick, The Theory of Monetary Policy, vol. 5, (London: Gray-Mills Publishing Limited, 1973).
Deficit Financing, the Debt, and “Modern Monetary Theory”
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Figure 8. IS-LM Curves in an MMT Model
Source: Nick Rowe, “Reverse-Engineering the MMT Model,” A Worthwhile Canadian Initiative (blog), 2011, at
https://worthwhile.typepad.com/worthwhile_canadian_initi/2011/04/reverse-engineering-the-mmt-model.html.
Notes: Interest rates (r) are measured on the y-axis, and output (Y) is measured on the x-axis. The figure
depicts an IS-LM relationship in a recession, where actual output (Y0) is lower than output would be at full
employment (Yn). Interest rates are assumed to be a policy variable, thus there is no difference between actual
interest rates (r0) and those at full employment (rn).
Because under the MMT model the selection of an interest rate plays no role in investment or
consumption decisions, proponents call for an interest rate that is more or less fixed at a lower
level than current targets. Providing for a low level of interest would reduce federal borrowing
costs, although fixing rates too close to zero raises questions about how the government and other
borrowers would convince creditors to lend money when the relative costs of holding more liquid
assets are lowered.19
Demand and Supply (AD-AS)
With interest rates assumed to be fixed and monetary policy largely taken out of business cycle
management, the MMT equilibrium output where aggregate demand meets aggregate supply is a
function of total factor productivity (as before, the capital stock is assumed to be fixed), fiscal
policy choices, and employment. If fiscal stimulus occurs in an underemployed economy, output
will increase. If the economy is at full employment, fiscal stimulus will not increase real output,
but rather induce inflation, which is a signal to undertake contractionary fiscal policy. With no
investment sensitivity to interest rates, or if the interest rate is fixed by the monetary authorities, a
fiscal stimulus at full employment will under the MMT model theoretically lead to an inflationary
spiral. This effect means that it would be crucial to be able to exert fiscal discipline if inflation
19 Under an MMT model with no institutional constraints, the federal government may not need to sell bonds in all
cases. However, the statutory independence of the Federal Reserve and Treasury (discussed further below) would
require federal bond issuances under current law.
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appears. Again, these effects are a function of MMT’s IS and LM assumptions and mirror the
fiscal policy findings in the “extreme Keynesian” mainstream view.
Unlike the mainstream model, where an increase in demand at full employment leads to a
contraction of the real money supply which chokes off demand (leaving the level of demand fixed
but its mix changed), there is no link between the IS-LM curve and AD-AS curve that produces
an equilibrium in prices and output. Instead, excess demand produces an increase in the price
level that must be met with a contractionary fiscal policy in MMT. (In effect, explicit action must
also be taken in the mainstream model where the Federal Reserve is managing business cycles,
but the Federal Reserve targets interest rates rather than money aggregates. The Fed must
recognize the inflationary pressure and take explicit action to offset it with higher interest rates.)
Proponents of MMT also advance a federal job guarantee. A job guarantee is not integral to the
MMT theory described above, because such a theory would presumably hold, according to MMT
advocates, regardless of the presence of the job guarantee. Nevertheless, it is widely advocated by
MMT proponents.
Although how the jobs guarantee is structured is largely undefined, such a policy would likely
reduce the fluctuation in employment levels across business cycles and increase government
deficit financing. It would presumably be designed to largely eliminate certain types of
unemployment (circumstances where individuals willing to work cannot find a job at a reasonable
wage either because of the business cycle or a mismatch of skills and labor demand), although
frictional unemployment (where individuals are engaged in job searches) would remain.
The specific characteristics and implementation process of any job guarantee would likely play a
significant role in determining its ultimate effect on output, employment, and price levels.
Because there is cyclical fluctuation in unemployment, the size of the guaranteed job workforce
would fluctuate, making a match between workers and needed tasks difficult. Unlike the market
economy that determines jobs and products based on consumer demand, the assignment of work
and output would have to be determined largely by fiat. When goods provided by the government
are not explicitly based on the needs for collective goods or goods with public spillovers (such as
a military force or highways), misallocation of resources may be more likely to occur. Some
resources would, theoretically, be diverted from the private sector with a higher effective
minimum wage through the government job alternative.
The job market in the United States is not uniform, presenting additional challenges for a
proposed job guarantee. For example, there could be considerable difficulties satisfying the
guarantee in sparsely populated rural areas, filling jobs requiring background checks, or because
some applicants may not be suitable for certain jobs (such as home health care or child care).
There are also issues about how to treat workers who violated the terms of employment (such as
persistent tardiness). Finally, jobs may need capital inputs (e.g., construction equipment) and
supplies, and workers in rural areas may have problems finding transportation.
The Open Economy
With an open economy the IS curve contains an additional element, net exports, which is
sensitive to interest rates. Mainstream economic theory postulates that if interest rates rise, capital
investment in the United States rises, increasing the demand for dollars, raising the price of the
dollar, and decreasing net exports (by both a decrease in exports, which are more costly to
foreigners, and an increase in imports). Applied to the MMT model, this would mean that the IS
curve would no longer be vertical because investment activity would respond to interest changes.
In that case, monetary policy that allowed the interest rate to rise would offset a fiscal stimulus.
Deficit Financing, the Debt, and “Modern Monetary Theory”
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However, the same output effects of fiscal policy as in the closed economy would occur if the
monetary authorities kept the interest rate fixed.
An open economy means that some U.S. debt is held by foreigners and adds to concerns that the
relatively low interest rates may make the financing of the debt more difficult, since the central
bank and the Treasury are independent. The low interest rates would make Treasury debt less
attractive to investors. This is important because Treasury must raise funds by selling bonds if tax
revenues are insufficient for expenditures, and the Federal Reserve cannot lend directly to the
Treasury under current law.20
Does MMT Justify Deficit Financing? Much of the analysis in MMT literature and related research focuses on its application in the
short-term, or in managing business cycles. Less discussed is how the MMT model applies to
long run economic variables, including growth and debt sustainability. This section discusses
MMT’s generally short-term view of deficit financing and contrasts it with mainstream
economics, which is usually focused on the longer term.
Mainstream economics does not call for balanced federal budgets, and is broadly supportive of
deficit financing in managing sufficiently large economic shocks. It does, however, recognize
limits on the amounts that the federal government (or any economic actor) may borrow:
constraints determined by the availability and willingness of investors to finance its borrowing
needs at normal interest rates. In the mainstream view, this borrowing is constrained by the total
amounts available for investment (savings in dollars) at a given point in time and the
attractiveness of other borrowing options available on the market. In the long term, this constraint
means that the amount of federal debt relative to output cannot rise indefinitely. In a basic
macroeconomic model this constraint is violated when the long-term interest rate exceeds the
long-term economic growth rate, as the general return on investments generated from
expansionary policy will be smaller than the interest payments required to finance that activity.
MMT proponents have generally called for a more active fiscal policy role in managing negative
economic shocks. Moreover, the MMT claim that sovereign governments that issue debt in their
own currency (like the United States) cannot be forced to default leads to the general perception
that an MMT-driven economic structure would involve larger deficits and higher debt levels than
those experienced in an economic structure shaped by mainstream economic thinking. This belief
is supported by the call for a central bank that consistently sets interest rates near or at zero,
which, all else equal, would support deficit financing at lower economic growth rates rather than
with higher interest rates if mainstream economic thinking was applied.
The notion that a sovereign government cannot be forced to default appears to be a central tenet
of MMT because of the view that money creation can substitute for taxes or borrowing to finance
government. There have been, however, many instances of sovereign governments defaulting
explicitly, or implicitly either by inflating the currency, renegotiating terms, or using other
20 Though the Federal Reserve can and does purchase Treasury Securities, the Federal Reserve Act (12 U.S.C. §226)
stipulates that it may only do so in the open market. For more information on this process, see Board of Governors of
the Federal Reserve System, “Why Doesn’t the Federal Reserve Just Buy Treasury Securities Directly from the U.S.
Treasury?,” August 2, 2013, at https://www.federalreserve.gov/faqs/money_12851.htm.
Deficit Financing, the Debt, and “Modern Monetary Theory”
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measures to address a difficulty in financing debt.21 These other options might be considered
default by another name.22
While the United States does not appear to face any current concerns about the ability to sell its
debt, were a collapse in the market to occur, it might be impossible or at least extremely costly to
undertake the needed measures (higher taxes to stem the inflation appearing with money
creation). In meeting its statutory mandate of minimizing long-run federal borrowing costs,
Treasury may redeem and reissue debt at levels that far exceed the amounts required strictly from
new deficit-financing activity. For example, Treasury issued $11.7 trillion in marketable debt in
FY2019, which represented more than 70% of the federal marketable debt portfolio.23 Any
dramatic increase in interest rates accompanying a debt crisis would thus likely generate higher
interest rates not only for debt generated by new federal deficits, but also for a significant portion
of the existing debt stock that is redeemed and reissued. For example, net interest payments
during the Greek debt crisis (described below) increased by amounts equivalent to roughly $200
billion in FY2019 dollars, which would require significant tax rate increases, base broadening, or
both if needed to meet a sudden change in interest obligations.24
If the federal debt position were viewed by the market to be unsustainable, it could lead to a
collapse in the demand for Treasury securities that would cause a “debt cycle.” In this case, an
observation by some investors to sell or avoid federal debt issuances before they defaulted would
raise federal interest rates, which would require more federal borrowing and could lead to further
investor avoidance and interest increases. Beyond the significant effects on the federal borrowing
position, such a process could also have ramifications elsewhere in the financial markets, as
federal securities are often used as a currency substitute for overnight interbank lending and other
activities central to general financial operations.
MMT proponents also claim that government deficits must be small enough to limit inflation. It is
unclear how this claim distinguishes MMT in a practical sense from the mainstream view, as
mainstream macroeconomics would also support fiscal or monetary intervention to avoid
significant increases in interest rates in response to rising debt. In the mainstream and MMT case,
there is concern that by the time actors identify an urgent debt sustainability problem, it may be
difficult to address. Such a situation would likely be accompanied by a negative economic shock
that would make immediately raising taxes (net of spending) difficult, while increasing the money
supply risks entering a debt spiral. In the MMT case, such a concern does not arise because of the
assumption that the Federal Reserve could finance spending (an assumption at odds with
institutional constraints discussed in the next section).
Further questions arise when examining the applicability of MMT policies to the United States
and other nations that already have relatively high real debt levels. In its most recent long-term
budget outlook, the Congressional Budget Office (CBO) estimated that federal debt held by the
public would rise from 78% of GDP in FY2019 to 92% of GDP in FY2029 and 144% of GDP in
FY2049, well beyond the historical peak.25 It is possible that a high existing debt stock could
21 See David Beers and Jamshid Mavalwalla, The BoC-BoE Sovereign Default Database Revisited: What’s New in
2018?, Bank of Canada, Staff Working Paper 2018-30, at https://www.bankofcanada.ca/wp-content/uploads/2018/07/
swp2018-30.pdf.
22 For more information, see CRS Report R44704, Has the U.S. Government Ever “Defaulted”?, by D. Andrew Austin.
23 U.S. Treasury, “Debt Position and Activity Report, September 2019,” September 30, 2019, at
https://www.treasurydirect.gov/govt/reports/pd/pd_debtposactrpt.htm.
24 World Bank, “Interest Payments (Current LCU)—Greece), accessed October 11, 2019, at https://data.worldbank.org/
indicator/GC.XPN.INTP.CN?locations=GR&view=chart.
25 Congressional Budget Office, The 2019 Long-Term Budget Outlook, June 25, 2019, at https://www.cbo.gov/
publication/55331.
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practically restrict the availability or effectiveness of MMT-supported fiscal policies in managing
business cycles, given the institutional constraints discussed in the next section. However,
currently there are no signs that the federal borrowing capacity is near exhaustion in the short
term or medium term, as interest rates remain below Fed-targeted levels.
Recent international experiences speak to the complexity of borrowing capacity. Both Greece and
Japan experienced rapid growth in government debt in the past decade. Organisation for
Economic Co-operation and Development (OECD) data on general government debt (including
municipal government debt) indicate that Greek debt rose from 115% of GDP in 2006 to 189% of
GDP in 2017, while Japanese debt rose from 180% of GDP to 234% of GDP over the same time
period. A loss in market confidence in Greek debt led to a severe recession there, with GDP
contracting by 9 percentage points in 2011, and long-term interest rates reaching 22% in 2012.
Japanese borrowing was viewed to be more sustainable despite being higher, with relatively flat
GDP levels and long-term interest rates close to zero in recent years.
Applying MMT to Federal Institutions
When weighing the merits of structural changes, it may be useful to consider the characteristics of
the institutions with power to address business cycles in the current system. Members of the
Federal Reserve Board of Governors have typically been chosen without regard to political
affiliation. The Federal Reserve’s Federal Open Market Committee meets at least every six weeks
to adjust open market operations as needed, allowing for a relatively quick and efficient way of
implementing monetary policy modifications.26 Fiscal policy decisions managing business cycles
are largely made through enactment of new legislation, and thus may be affected by the
legislative calendar and other political considerations.27 In practice, these factors may make the
evidential threshold for a fiscal policy response higher than that for action by the Federal Reserve.
The Emergency Economic Stabilization Act of 2008 (P.L. 110-343), for instance, was enacted in
part to alleviate effects of the Great Recession in October 2008, 10 months after the start of the
recession as identified by the National Bureau of Economic Research.28 In contrast, the Federal
Reserve also undertook significant action in fall 2008, but was also able to begin taking
countercyclical actions as early as September 2007.29
One may also wish to be mindful of the current independence of the Treasury and the Federal
Reserve. In MMT, these groups are treated as a single entity, which is equivalent to assuming that
the Federal Reserve can make funds available to the Treasury to spend as it needs. Present laws
prohibit the Federal Reserve from lending or allowing overdrafts to the Treasury, so the Treasury
must sell bonds at whatever interest rate prevails when revenues are inadequate to finance
spending. The Federal Reserve faces no statutory limits on how much federal debt it may
purchase in the secondary market, however, so that it can lend indirectly. The degree of
26 For more information on the Federal Reserve, see CRS In Focus IF10054, Introduction to Financial Services: The
Federal Reserve, by Marc Labonte.
27 Examples of political influences on fiscal policy responses can be found in Andrea Louise Campbell and Michael W.
Sances, “State Fiscal Policy During the Great Recession: Budgetary Impacts and Policy Responses,” The Annals of the
American Academy of Political and Social Science, vol. 650 (November 2013), p. 252.
28 National Bureau of Economic Research, “US Business Cycle Expansions and Contractions,” September 2010, at
https://www.nber.org/cycles.html.
29 Board of Governors of the Federal Reserve System. “The Great Recession: December 2007-June2009,” November
2013, at https://www.federalreservehistory.org/essays/great_recession_of_200709.
Deficit Financing, the Debt, and “Modern Monetary Theory”
Congressional Research Service 22
independence between the Federal Reserve and the Treasury has varied over time, however, with
periods of relatively high cooperation.30
Even if the Federal Reserve can lend indirectly to the Treasury, it has different objectives than
cheap financing of the debt. The Federal Reserve acts under a statutory mandate of “maximum
employment, stable prices, and moderate long-term interest rates.”31 If the Federal Reserve
determines, for instance, that such a mandate warrants contractionary policy, it has the authority
to enact contractionary policy, even if such actions would negate expansionary fiscal policy
efforts. It is possible, therefore, that MMT-supported policies may need the support of both
federal policymakers and Federal Reserve actors to take full effect. Economists have justified
delegating this authority to the Federal Reserve on the ground that an insulated institution is more
likely to choose policies consistent with low inflation. If correct, subordinating the Federal
Reserve could result in a choice of policies under the MMT framework that removes this check
against high inflation.32
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Author Information
Grant A. Driessen
Analyst in Public Finance
Jane G. Gravelle
Senior Specialist in Economic Policy
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